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In short, Muddy Waters is not the issue here, it is Olam's strategic and
financial decisions that have brought this situation to a head.
OLAM'S announcement of a major financing package this week has been
characterised as ranging from a "government bailout" to a "vote of
confidence". Either way, it is time for Olam to get serious about creating
long term sustainability. Having missed the point earlier this year from
the Feb 21 CLSA report, the emergence of a significant short position, a 30
per cent decline in Olam's share price since and the resignation of Olam's
20-year CFO in June, Olam's management and board remain in denial. The
short-seller research firm Muddy Waters produced an extensive 133 page
report which Olam dismissed as out of hand and responded to with a lawsuit
which dilutes management bandwidth, wastes shareholders' money and does not
address the root causes of Olam's problems. In short, Muddy Waters is not
the issue here, it is Olam's strategic and financial decisions that have
brought this situation to a head.
The latest Temasek-backed transaction raises significant issues, as it is
extremely expensive debt and equity capital, capital that Olam spent a week
telling the market it didn't need. The package of US$750 million of
five-year debt and so-called "free" warrants are hardly free as they have
tremendous value.
Black-Scholes models have valued these warrants to be
worth an estimated US$127 million. Since Olam's proposed US$750 million of
debt is priced at 95 per cent of par, the proceeds, before fees, are
actually US$712.5 million including the warrants. By backing out an
estimated warrant value of US$127 million, the true bond value is actually
only US$585 million, equal to 78 per cent of the original bond value. Thus,
the true yield on the bond is not the 8 per cent that Olam would like
investors to believe, but rather a whopping 13 per cent. Given the generous
nature of these terms and Temasek's commitment to fully take up the rights
issue, one has to wonder why Olam is paying US$15 million in underwriting
fees to the banks who are taking no risk. If you back out those fees, the
cost of this debt is an even more eye-popping 13.7 per cent.
In other words, Olam is offering existing investors a
bond yielding an
estimated 13 per cent and at-the-money warrants which can only be exercised
in years 4 and 5. No wonder Temasek wants to underwrite the entire deal -
this is the sale of the century, just in time for Christmas. But before
shareholders get too excited about shiny packages under the tree, they
should consider that this is just a left-pocket, right-pocket deal. The
shareholders are paying for this lavish set of terms. The real losers are
the bondholders, not to forget the investors who only a few months ago
bought the US$275 million perpetual preferred shares issued at 100 per cent
that are now quoted at 82 per cent. Their already over-leveraged securities
just got more risky and they get no benefit from this package. And of
course any investors unable to take up their rights will see them go to
Temasek, who has no shortage of capital.
Muddy Waters' boss Carson Block did not magically create these concerns. He
merely capitalised on a well-researched bet. This process is explained with
wit and insight in
The Big Short by the author Michael Lewis and is a healthy aspect of
capitalism.
Now the market is left to sort out what is true and what the
end game is.
Since this has not been done yet, I hereby submit to Olam's shareholders a
10-point plan of "tough love" to restore credibility and take definitive
actions to reposition a great company for a healthy future:
1) End the war of words. Anyone reading Muddy Waters' 133 page report will
see a credible work of research. The market has not been impressed with
Olam's attempts to discredit Muddy Waters with ad hominem attacks and
lawsuits. What's needed now are strong actions, not words.
2) Raise equity, not more debt. Olam made a strategic error in saying
equity was not needed until 2015. It needs equity now. Its net gearing of
248 per cent is well in excess of industry norms and the US$750 million new
debt makes matters worse and adds USD/SGD foreign exchange risk to boot.
Olam should cancel the egregiously expensive debt issue and execute a
meaningful equity rights offering giving the KC Group, Temasek and
management the opportunity to take up rights that are unsubscribed, if any.
This will underpin Olam's equity capital while demonstrating the commitment
of its largest shareholders and management. Selling 13 per cent debt with
at-the-money warrants is a sign of desperation.
3) Immediately stop the capital expenditure programme. This is essential as
the supply of cheap debt is over. Olam's board must stop the acquisitions,
conserve cash and prove the value of the acquisitions to date.
4) Focus on generating positive cash flow as soon as possible. Rule No 1 of
battlefield triage is to stop the bleeding. Negative cash flow while
executing a capex and acquisition programme with ever increasing leverage
is untenable.
5) Sell secured receivables. Olam has said that its secured receivables are
as good as cash. It should demonstrate that by selling a meaningful amount,
raising cash, paying down short term debt, creating liquidity and
convincing the market of these receivables' cash-like properties.
6) Draw down a portion of both committed and uncommitted bank lines. Olam
is currently closed out of the fixed income capital markets and the
availability of its undrawn, fully committed and uncommitted facilities
remains in question. In light of Olam's significant upcoming 2013 debt
maturities, showing the availability of committed and uncommitted
facilities would boost market confidence.
7) Get the debt rated. Olam has raised billions from the Singapore debt
markets with no independent rating of creditworthiness. An independent
assessment of Olam's credit is required for investors, many of whom are
individuals. The argument that others in the industry do not have a rating
is untenable and specious. Olam's net gearing of 248 per cent far exceeds
Noble's at 107 per cent and Wilmar's at 88 per cent. The MAS and SGX, whose
silence have been deafening, should also publicly back this initiative.
8) Do not buy back stock. A stock repurchase programme burns valuable cash,
increases leverage and will not impact Olam's share price. In fact, it
would likely only further worsen the precipitous declines in its bond and
preferreds prices.
9) Declare if management shares are on margin or pledged. While in the
past, it could perhaps be argued that this is a personal matter, with so
many questions hanging over the company, management needs to treat its
shareholders as partners and declare if any shares are encumbered and could
be force-liquidated at a given price point and if so, what that is.
Olam should also disclose the timeline of the events leading up to the
announcement of the Temasek underwriting as the storyline has been
shifting. Olam claimed this was its idea over the weekend and had the
bankers take it to Temasek. Yet Olam also said last Friday that the CEO and
two board members bought significant shares in the company. Did the idea
emerge after those purchases were made and if so, when and how? There is no
need to have questions about possible conflicts of interest when a simple
timeline can put the issue to rest.
10) Don't rely too much on Temasek in future. Too often the market believes
that when Temasek is invested for over 15 per cent, they will underwrite
problems that occur and banks, investors, management, and boards can then
get sloppy and lazy. As a professional investor, Temasek will do what is in
its commercial interest and those who bet on additional bailouts may one
day have a rude awakening, as has happened in the past. The US$750 million
debt and warrants package is one sweet deal for Temasek and is not being
done for charitable reasons.
Olam, as a trading business, has failed to grasp the realities of the
post-financial crisis era. Today balance sheets, accounts and financing
must be beyond reproach. Olam has not achieved this, but has continued to
travel a dangerous path in recent years fuelled by readily available
credit. It has a fiduciary responsibility to its equity and debt investors
to respond with a credible and thoughtful plan of action to preserve and
enhance value.
Olam has paid an extremely dear price to Temasek to buy some time. How it
proceeds from here will be the existential question.
By Michael Dee, an investment banker for over 30 years, was Morgan Stanley's regional CEO in Singapore and a Senior Managing Director of Temasek Holdings from August 2008 to April 2010. He has no position in any Olam securities.
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